Capital Gains Tax (CGT)

Highlights
Capital gains on the disposal of most assets are taxable.

How are capital gains taxed?
Capital Gains Tax (CGT) is not a separate tax but forms part and parcel of the income tax system. As such it is governed by the general administrative and other rules in the Income Tax Act, in addition to having its own special rules. Although, in general, capital receipts are excluded from gross income, and therefore from taxable income, a capital gain arising from any disposal of a capital asset on or after 1 October 2001 is brought back into taxable income. Personal effects and certain other assets are excluded. However only 25% of the gain is included in taxable income in the case of a natural person, while 50% of the gain is included in the case of other taxpayers (in the main, companies, close corporations and trusts). The capital gain is then taxed together with all other types of income in the normal way. The result is that, at the maximum marginal tax rate for individuals, the effective rate of CGT is 10% for individuals, while the effective rate for companies and close corporations is 14%, and 20% for trusts.

Any capital gains may be offset against any losses or assessed losses for income tax purposes. However, if a capital loss is incurred, it cannot be offset against other income for tax purposes. The capital loss can only be offset against other capital gains, or if there are no, or insufficient, gains to absorb the loss, the excess loss is carried forward indefinitely to be offset against future capital gains.

In the case of natural persons only, there is an annual exclusion of R17 500 (2008/2009 tax year R16 000). Thus before applying the 25% factor referred to above, a natural person’s net capital gains or net capital losses for the year are reduced by R17 500. This amount increases to R120 000 in the year of death. These exclusions do not apply to other taxpayers.

Who is subject to CGT?
All persons who are residents for purposes of income tax are subject to CGT on disposal of their worldwide assets. Non-residents are also subject to CGT but only in respect of immovable property in the Republic, the assets attributable to a permanent establishment of that person in the Republic and certain interests in immovable property in the Republic. If a non-resident holds a direct or indirect interest of at least 20% in the equity share capital of a company, trust or other entity, where 80% or more of the value of the non-resident’s interest therein is attributable directly or indirectly to immovable property in South Africa, such interest will, on disposal, be subject to CGT.

As from 1 September 2007, a withholding tax on amounts paid to non-resident sellers of immovable property situated in the Republic was introduced as follows:

• 5% of the amount payable if the seller is a natural person;
• 7.5% of the amount payable if the seller is a company;
• 10% of the amount payable if the seller is a trust.

Calculation of gain
It is not every accretion of capital that results in CGT being payable. The tax is payable only if there is a capital gain arising on the disposal of an asset. The gain is the excess of the proceeds over the base cost.

Disposal
Before a capital gain can arise there must be a disposal of an asset. The term, however, is extremely widely defined and includes transactions and events which one would not ordinarily include in the term ‘disposal’. Thus the term includes a donation, conversion of an asset (e.g. a conversion of one type of share into another) the extinction of an asset (e.g. an option terminating) or the destruction or scrapping of an asset, among others. There is also a deemed disposal (and immediate re-acquisition) of assets when a person dies, gives up residence (see ‘Income tax; Basis of taxation; Residence rules’) or acquires residence in South Africa. The effect of this is to trigger CGT on death or emigration and to step up the values on immigration (assuming that such assets have increased in value).

Proceeds
Proceeds generally represent the amount received on the disposal of an asset but there are also some provisions which result in market values being deemed to be ascribed, particularly in relation to transactions between connected persons as anti-avoidance measures. Certain transactions between connected persons (as defined) are deemed to be at market value, as in the case when a company distributes an asset in specie to its shareholder or a trust distributes an asset to its beneficiary - in such case the company or trust is deemed to dispose of the asset for market value proceeds. The shareholder or beneficiary is then deemed to acquire the asset at such market value.

Base cost
The base cost represents the actual cost (or deemed cost) of the asset acquired. There are also certain additional amounts which can be included such as transfer costs or stamp duty, moving or installation costs, professional fees, interest in very limited circumstances, and so on.

In the case of assets held on 1 October 2001, the date CGT first became applicable, the base cost is arrived at by using one of three methods:

• Market value
  This requires that the asset be re-valued. Shares, bonds, debentures, mutual fund units, etc. in South Africa are valued at listed price subject to certain adjustments. For this purpose SARS has published the prices as adjusted. The market value of foreign listed instruments is based on the foreign listed price. For instance, the ruling price on the last business day prior to valuation date is regarded as the market value. The ruling price is the last sale price at close of business of the exchange unless there is a higher bid or lower offer on that day subsequent to the last sale in which case the price of the higher bid or lower offer will prevail. Unlisted assets must be valued on a willing buyer, willing seller basis and, depending upon value, the valuation must have been performed by 30 September 2004. There are various other requirements and anti-avoidance provisions.
• The time-apportionment base cost
  Under this method a pro-rata proportion of the profit relating to the period prior to 1 October 2001 is added to the actual cost so as to effectively exempt that portion of the profit from tax. For example, if an asset cost R100 on 1 October 1996 and was sold for R400 on 30 September 2011, i.e. it was held for 5 years pre-implementation and 10 years thereafter, 5/15 of the profit of R300, or R100, is added to the actual cost of R100 to give the time-apportionment base cost of R200. Thus CGT will be payable on R400 - R200 = R200.
• 20% of proceeds
  Generally, this method will be used when there are inadequate records to establish the time-apportionment base cost and no valuation was undertaken.

A taxpayer is free to choose any one of the above methods and the choice will be made at the time of sale, so as to establish which will give the highest base cost.

There are, however, a number of loss limitation and other anti-avoidance rules. Thus, for example, if an asset cost R100 and the market value on 1 October 2001 was R150 and the asset was actually sold for R130, it will not be possible to claim a loss of R20.

Exclusions
Gains arising on disposals of certain assets are excluded in whole or in part, so that they are effectively exempt from CGT.

Note, however, that in order for a number of these exclusions to be applicable, certain criteria must be met:

• Primary residence
  The first R1.5 million gain on the disposal of a primary residence is exempt from CGT. In his budget speech for the 2009/2010 tax year, the Minister announced that where the gain proceeds on the sale of a primary residence are R2 million or less, no CGT will be payable on such disposal.
  
  A primary residence must be owned directly by a natural person and must be one in which that person or his or her spouse ordinarily resides as the main residence and is used mainly for domestic purposes. There can be only one primary residence at a time, and if one changes a primary residence for another without selling the first, the exemption of R1.5 million is apportioned between the two residences on a time basis.
• Personal-use assets
  These are assets held by a natural person used mainly for purposes other than carrying on a trade. They would thus typically include personal effects and motor vehicles, art collections, jewelry, stamp collections, etc, as long as they are not traded in. Specifically excluded from being personal-use assets, and therefore still subject to CGT, are gold or platinum coins where the market value is mainly attributable to the material (e.g. Kruger Rands), immovable property, any financial instrument, an aircraft whose empty mass exceeds 450 kilograms and a boat exceeding 10 metres in length (note that as regards the two last-mentioned items, no capital loss may be claimed but only a gain is taxable).
• Retirement benefits
  These would include lump sums from pension, pension preservation, provident, provident preservation or retirement annuity schemes or similar funds outside South Africa.
• Long-term assurance
  The gain is excluded only when the policyholder receiving the gain is the original beneficial owner of the policy or the spouse, nominee, or dependant or deceased estate of the original beneficial owner, or it is a key man or partnership policy. In all cases the policy must be taken out with a South African insurer. Thus second-hand policies and foreign policies are still subject to CGT or possibly income tax.
• Disposal of assets of a small business
  This assumption applies to the disposal of certain ‘small business assets’ by an individual. There are various rules but in general the market value of the assets must not exceed R5 million and the exempt amount is a maximum of R750 000.
• Disposal of assets of a micro business
  50% of the receipts of a micro business that are of a capital nature are included in the taxable turnover of such entity.
  
• Gambling, games and competitions
  This applies only to winnings accruing to a natural person and then only if the form of gambling, game or competition is authorised by and conducted in terms of South African law.
• Unit trusts
  Here the unit trust does not itself pay CGT but the unit holder will pay on disposal of the units. This applies both to equity and property unit trusts.
• Donations and bequests to public benefit organisations
  Normally a donation is deemed to be a disposal at market value and therefore triggers CGT, but this deemed gain is ignored where the recipient is a public benefit organisation.

Roll-over relief
Roll-over relief means that the gain or deemed gain on a transaction is not immediately taxed but is ‘rolled over’ into the next transaction. In other words, roll-over relief results in a deferral of, but not exemption from, CGT.

There are six forms of roll-over relief, as set out below:

• Involuntary disposal
  This arises by way of expropriation, loss or destruction of an asset. If the proceeds are expended in replacing the asset, the gain is disregarded at that time and is instead taxed when the replacement asset is sold.
• Reinvestment in replacement assets
  This relates to depreciable assets (e.g. plant and machinery, ships, aircraft, etc.). If a gain arises on disposal and the proceeds are used to replace the asset, the gain is spread over the write off period applicable to that asset.
• Transfer of assets between spouses
  In such cases no gain arises in the transferor or transferee spouse’s hands but the transferee is treated as having acquired the asset on the same date as the transferor originally acquired it, for the same expenditure on the same date as the expenditure was incurred by the transferor and in the same currency, used the asset in the same way and received an amount that would have constituted proceeds equal to any amount received by or accrued to the transferor in respect of the asset if it had been transferred a person other than the transferee i.e. the ‘tax profile’ of the asset is transferred. The same rule applies where a deceased spouse bequeaths an asset to his or her surviving spouse.
• Interests in collective investment schemes (CIS) in property
  The holder of an interest in a CIS shall be deemed to have disposed of his interest in the CIS on 1 July 2011 if he had received cash or acquired assets before 1 October 2007 and his interest in the CIS had not been disposed of by 1 July 2011. In respect of cash or assets received after 1 October 2007, disposal shall take place on the date of receipt of such cash or assets.
• Transfer of a unit by a share block company to its member
  No gains or losses take place when the company disposes of a unit to the shareholder or the shareholder gives the share back to the company as the property merely takes the place of the share in the shareholder’s hands.
• Mineral rights conversions and renewals
  There is no disposal where certain old mineral rights are converted into new mineral rights.

Similar relief is given in relation to corporate restructurings, including the rationalisation of a group, forming of new business entities, mergers and the like. The rules are extensive and replete with exceptions and strict requirements, and do not merely provide roll-over relief for CGT purposes but also relate to other fiscal issues, e.g. they deal with depreciation allowances, recoupments and scrappings, bad debts, exemptions from STC, exemptions from stamp duty, etc. (see ‘Income tax; Companies; Corporate restructuring rules’).

Assets acquired or disposed of for contingent or un-quantified amounts
If the proceeds of sale have not ‘accrued’ to the taxpayer because they are contingent or conditional, they are not taken into account the year of disposal. In addition, there is no capital loss from that disposal unless the proceeds never materialise. Once they accrue to the taxpayer, there is a base cost until the cost thereof is actually incurred (i.e. the obligation to pay is unconditional) albeit unpaid.

Assets disposed of for un-quantified (but accrued) proceeds
The proceeds of disposal are not recognised for CGT until they are quantified (albeit unpaid) so that the proceeds may be liable to CGT only in subsequent tax years. However, the disposal (and deduction of base cost) is recognised in the year of disposal and hence a CGT loss may arise in that year.

Equity shares
Similar rules apply to the disposal and acquisition of equity shares, where, inter alia, more than 25% of the purchase price is payable after the seller’s year end and such amount is based on the future profits of the company.

Foreign currency gains and losses
Gains or losses arising from foreign currency movements in relation to the rand were ignored for CGT purposes up to 28 February 2003. The CGT rules require that the taxpayer calculates the gain or loss based on the gain or loss in foreign currency (this exclusion does not apply when an asset is acquired in one foreign currency and sold in another and there is a currency gain or loss between the two foreign currencies) and then converts that gain or loss into Rands.

There are two basic exceptions to this rule:

• Where the asset is a foreign equity instrument. Broadly, this means any foreign listed or unlisted share, foreign unit trust, foreign derivative or a coin made mainly from gold or platinum. In such case the currency gain or loss is taxable. But where the asset comprises a foreign bank account, unlisted loan, immovable property, etc. the currency gain is excluded by converting the purchase price of the asset at the rate of exchange ruling on date of sale.
• Where foreign currency itself, or forward exchange contracts or foreign currency option contracts and other similar transactions result in gains to any trust which does not carry on any trade or to any natural person (except natural persons who hold the foreign currencies asset, options, etc. as trading stock), certain specific and detailed rules apply. These rules, however, can never apply to a company or close corporation as all their gains and losses are included in taxable income in terms of Section 24I of the Income Tax Act.

Transfer of residence from a company or trust

A window period has been introduced into the legislation whereby individuals who currently own their private dwelling in a company, close corporation or trust can transfer such property into their own name without incurring any CGT, transfer duty or STC. The window period closes on 31 December 2011.